Well-Designed Public Procurement Can Open Markets

A small stationery supplier in São Paulo wins a government contract to furnish schools with paper and ink. The contract lasts barely a year, but the impact lingers: new hires, a modest ad campaign, a few second-hand machines. Two years later, the firm is still larger and selling more to private clients. What appears to be a routine government purchase turns out to be a growth policy in disguise.

That is the central finding of Procuring Firm Growth, a 2021 study by Claudio Ferraz, Frederico Finan, and Dimitri Szerman, which illustrates how government public procurement may stimulate growth among isolated firms by linking them to larger buyers. Yet, it is not the entire story. As another study in Brazil reveals, government contracts in markets dominated by a few large employers can also reinforce those firms' power to set wages and limit job creation. 

A discussion of these dynamics and the policies they suggest are crucial elements in the IDB’s soon-to-be-released Development in the Americas flagship report, which examines market power and the challenges and possibilities for positive economic and social transformation from greater competition. It is crucial to understanding how government-led demand, depending on the circumstances, can have both positive and negative effects. 

Using millions of online procurement auctions in Brazil, the authors of the first study, Procuring Firm Growth, show that government demand can loosen one of the least discussed constraints on small firms: finding reliable buyers. Because the auctions end at a random moment, the identity of the winner in “close” contests – where bids differ by less than one per cent – is as good as random. This feature lets the researchers compare firms that narrowly won or lost a contract as if by coin toss.

The results are illustrative. A one-standard-deviation increase in the value of government contracts raises firm employment by about 4.2%. Sales and value-added also increase. The effect lasts well beyond the life of the contract, which typically runs six to 12 months. Public orders do not crowd out private ones: firms’ private-sector sales grow just as much as their total sales. The data suggest that the temporary demand boost allows firms to invest in machinery, inventories, and advertising – large, infrequent outlays that are hard to finance without a guaranteed revenue stream.

From these results, the authors infer that limited market access remains a key barrier to firm growth. As they note, “lack of access to markets (because of distance or lack of knowledge) seems to play an important role in constraining firm growth. Thus, policies that alleviate this constraint, either by informing firms of potential markets or reducing barriers to selling in larger markets, could enable firms to grow.” 

In other words, connecting firms to demand can matter as much as lowering their costs. Market fragmentation – across regions, sectors, or supply chains – can hold back the reallocation of resources to more productive firms. By linking isolated producers to larger buyers, whether public or private, governments can help overcome one of the central obstacles to development: too many small markets.

The second study asks what happens next – when one firm’s windfall becomes another’s challenge. Identifying Labor Market Power: A Quasi-Experimental Approach by João Galindo da Fonseca and Rogério Santarrosa exploits the same Brazilian public auctions to trace how those demand shocks ripple through local labor markets.

First, the authors confirm the earlier finding: auction winners increase employment by about 2% and raise wages by 1% to 1.5% over the next two years. They then examine how nearby competitors respond. In the same location and industry, wages in rival firms rise by 0.15%  to 0.23%, while employment barely changes. In plain terms, when a firm hires more workers and pays more, others must follow suit to retain staff. Competition for labor drives up wages.

The pattern is strongest where the winning firm commands a large share of local employment – a telltale sign of monopsony power in which a few buyers face many small sellers. In those concentrated markets, a 1% rise in the winner’s wages prompts competitors’ wages to rise by up to 0.5%. The fact that pay adjusts but headcount does not fits theories in which firms exert some degree of labor-market power.

These findings shift the lens from product to labor markets. Market power is not only about prices and profits; it also shows up in how wages respond to local shocks. The Brazilian data provide rare causal evidence of these dynamics – something that standard concentration indices often miss.

Together, these studies reveal both the potential and the limits of government-led demand. Government contracts can help firms break through demand and credit constraints, fostering growth and private investment. Yet in markets dominated by a few large employers, the same mechanism may reinforce wage-setting power and limit job creation.

The broader lesson is that competition – or its absence – shapes how policy transmits through the economy. A competitive procurement system can double as a growth engine; a concentrated one risks locking power in place. Policymakers should look beyond fiscal multipliers and ask who truly gains market access and bargaining power.

These insights lie at the heart of the Inter-American Development Bank’s forthcoming 2025 Development in the Americas report, Markets for Development: Improving Lives through Competition. Drawing on new evidence from across Latin America and the Caribbean, it explores how market power affects prices, innovation, jobs, and inequality—and how stronger competition can raise living standards across the region.